September 07, 2010

SEC and CFTC Chairs Participate in FDIC Roundtable on Dodd-Frank Resolution Authority Title

Title II of the Dodd-Frank Act establishes an orderly liquidation authority to unwind complex systemically important financial firms whose failure could put the entire financial system in jeopardy. The FDIC is the designated receiver of such a financial firm. Recently, the FDIC held a roundtable on the Title II liquidation authority.

SEC Chair Mary Schapiro emphasized the need for a team approach to resolution, including the primary regulators, since these firms often have multiple subsidiaries and affiliates and multiple regulators. The team should meet with firms on their resolution plans so they don’t have to get up to speed when the resolution authority is invoked.

Industry participants stressed the need to identify key people who will keep the systemically important parts of the firm going if the unfortunate event of going into receivership. A senior officer should be designated to interact with regulators and oversee the process and deal with regulatory issues, and look at critical functions and resolution plans. Also, there must be plans to keep the business functioning during the transition to FDIC receivership. There must also be a focus on identifying critical services that the firm must provide to the marketplace. FDIC must ensure that these critical services continue, such as clearing and settlement of government bonds and maintaining the ATM network.

CFTC Chair Gary Gensler asked if derivatives would involve such critical service. Barry Zubrow, Chief Risk Officer of JP Morgan Chase said that, while his firm is a derivatives counterparty, the firm would not identify derivatives trading as a critical service since many others in the marketplace can provide derivatives services. FDIC Chair Shelia Bair said that the FDIC may adopt an approach for different derivatives asset classes. The FDIC may have to put a derivatives book into a bridge entity to keep it going. The Chair said that the FDIC will make quick decisions on what should be put into a bridge entity or into receivership, using the criteria of what will maximize recovery for creditors.

FDIC Vice Chair Martin Gruenberg noted that Dodd-Frank gives the FDIC the tool of using a bridge firm in using the resolution authority. He said that the FDIC will adopt regulations defining how the FDIC will use this authority to create a bridge firm, adding that the only creditors allowed to be transferred into a bridge firm would be those who maximize franchise value and are essential to the operation of the bridge.

CFTC Chair Gensler said that firms should designate a point person for cleared and non-cleared derivatives. He also pointed out that, under the Commodity Exchange Act, the CFTC can put a clearing house into receivership, and that the FDIC now has that capability. The CFTC plans to do a MOU with FDIC on this aspect.

There was also a consensus among industry participants that the resolution authority must involve international regulators in the process because global firms may have to prepare different resolution plans. It is important to coordinate internationally on a multi-jurisdictional basis since preparing multiple living wills for different jurisdictions is fundamentally impractical. The FDIC Chair said that the reality is that, in the short term, there will be ring fencing, but in the long term regulators will work together to have globally consistent resolution regimes. There was a consensus among industry participants that firms will structure some businesses differently because of ring-fencing.

Industry participants saw a need to have a pre-determined mechanism to value illiquid securities that cannot be priced. If security is illiquid and there are no trades in the security for a few days, a value of zero is assigned, which may not always be true. The FDIC Chair said that there will always be a problem with liquidity in a crisis; and that regulators will need current valuations and real time information. The FDIC Chair envisions starting from a bankruptcy premise, where equity will take loss first, then debt, then senior debt, and then secured creditors will be protected only up the point of their collateral and if the collateral is illiquid there will be a possibility of loss.

FDIC Chair Shelia Bair also said that the FDIC has the ability to differentiate among creditors to maximize recovery but it will be used sparingly, most of the time FDIC will use the bankruptcy rules. It will be important to see what non-bank financial firms are designated systemically risky.